A Vanguard ETF 5 Year Scorecard

In celebration of the five-year anniversary of the market bottom on or about March 9, 2009, I have compiled a statistical look at all Vanguard ETFs that were in existence before that date to see what lessons investors can draw from their performance.

The table below lists all twenty-eight Vanguard ETFs in existence before March 9, 2007. The oldest is VTI - Total Stock Market - which opened for business on May 24, 2001, and the youngest is VEU - FTSE All-World ex-US - which began trading on March 2, 2007.

To compile the data below, I downloaded the adjusted closing prices of all twenty-eight ETFs for the period from March 9, 2007 to March 9, 2012 (source: Yahoo Finance). I then extracted the highest closing price before the 2007-09 crash, the lowest closing price at the market turning point on or about March 9, 2009, and the closing price on 3/9/2012. Using these data, I calculated the percentage drawdown from the pre-crash high to the post-crash low, the percentage rise from the post-crash low to the price on 3/9/2012, and percentage gain or loss - relative to the pre-crash high - of the closing price on 3/9/2012.

In addition, I include three five-year performance statistics: five-year total return, five-year standard deviation, and 5-year Sortino ratio (source: Morningstar). Because VEU has just recently passed it fifth birthday, its five-year standard deviation and Sortino ratio are not yet available.

Sortino ratio is particularly important, since it provides a measure of return relative to the risk taken over the five-year period. It is a modification of the better-known Sharpe ratio, which compares an investment's total return to its standard deviation. The higher the Sharpe ratio, the better. But upside volatility isn't an issue for investors: it's good when your investments go up. So the Sortino ratio compares an investment's total return only to its downside volatility, and thus provides a better measure of how much reward you get for the downside risk you take. As with the Sharpe ratio, the higher, the better.

The table below sorts the data by five-year total return. The right-most column indicates each ETF's type, either stock, sector, or international. Although it is hard to imagine now, no Vanguard bond ETFs yet existed on 3/9/2007.

What's most noticeable at first glance is the magnitude of the decline from the pre-crash high to the post-crash low: -58% on average, -79% for financials, -71% for REIT. Any investor who buys stock ETFs, Vanguard or otherwise, needs to understand the risks involved. If another crash happens, your investments can lose more than half their value. Buyer beware.

Second, the ETF that lost the least in the crash, VDC (-34%), also had the highest five-year total return. In fact, it's broadly true that ETFs that crashed the least produced the best five-year returns. The correlation coefficient for percent decline (expressed as a negative number) and five-year total return is moderately positive at .54 (where -1.0 represents perfect inverse correlation and 1.0 perfect positive correlation). The four ETFs that lost less than 50% in the crash - VDC, VHT, VPU, and VIG - had an average five-year total return of 5.13%, compared to the overall average of 2.95%.

Nevertheless, ETFs that dropped a lot also gained a lot in the three years after the market bottom, although not always enough to compensate for their losses. To break even from a -50% lost requires a 100% gain. The average -58% loss for the ETFs in the table required a 138% gain to break even, but on average the ETFs only gained 135%. In dollar terms, $10,000 invested in the average ETF became $4,200 at the market bottom and rebounded to $9,870 by 3/9/2012.

The best rebound from a drop of more than 50% came from VCR - Consumer Discretionary - which dropped -62% but rebounded 201%, so that $10,000 invested at the pre-crash high rebounded to $11,438 by 3/9/2012. But the highest overall rebound of 226% wasn't enough bring VNQ - the REIT ETF - back to break-even by that same date. $10,000 invested at the pre-crash high declined to $3,900 by the bottom and only recovered to $9,454 by 3/9/2012.

Overall, as of 3/9/2012 eleven ETFs closed higher - on an adjusted basis - than their pre-crash high. They are listed below.

Four of the eleven are sector ETFs: Consumer Staples, Consumer Discretionary, Information Technology, and Health Care. The other seven are stock ETFs, with a tilt toward growth, mid- to small-caps, and dividends: Extended Market, Growth, Mid-Cap, Mid-Cap Growth, Small-Cap, Small-Cap Growth, and Dividend Appreciation. Large-caps and value ETFs are nowhere in sight (unless you count VIG as a value play). Overall they produced a decent 5.43% total return, but with a pretty formidable standard deviation of 21.15. The moral of the story here is that mid-cap, small-cap, and growth ETFs can make you money, but only if you have the stomach for the volatility.

The three exceptions to the high standard deviations in the table above are Consumer Staples, Health Care, and Dividend Appreciation. Their average five-year standard deviation was 14.98 and their average five-year return was 5.96%. For more conservative investors, these three funds might be the best bets for long-term gain with less volatility.

Similar comments apply to the list below of the best ETFs with five-year total returns greater than 4%.

This table adds three ETFs not in the previous table - Energy, Emerging Markets, and Materials - none of which was above its pre-crash high on 3/9/2012 - and omits Mid-Cap, since its total return was less than 4%. But the profile is similar: six sector, six stock, and one international ETF. It's a pretty diversified list with an average five-year total return of 5.49%, but, again, with a formidable standard deviation of 22.63.

So the question is, how can investors use this information to find ETFs they might want to buy? Here's one answer: pay attention to Sortino ratio. In a highly volatile market like the last five years, you want to own the ETFs that give you the best return for the risk you take. Since Sortino ratio calculates the ratio of return to downside risk, it's a number you want to watch. To understand how it can help clarify the options and choices to be made, consider the table below, which sorts the thirteen ETFs from the previous table first by investment type and then by Sortino ratio.

For stock ETFs, the clear winner on pure performance is VBK - Small Cap Growth - which has the highest Sortino ratio, the best five-year total return, and the highest price on 3/9/2012 relative to its pre-crash high. But its five-year standard deviation is also the highest of all the stock ETFs, so it's not for the faint of heart.

A close second and perhaps better choice is VUG - the Growth ETF - which has a lower standard deviation and still decent five-year total return and Sortino ratio. It's a good option for someone looking for solid performance with less volatility.

In third place, the ideal choice is probably VIG - Dividend Appreciation - because of its relatively low drawdown during the crash and relatively low standard deviation. This is probably the best stock ETF in the list for conservative investors.

For sector ETFs the clear winner and best choice in the whole table is VDC - the Consumer Staples ETF. It has the highest Sortino ratio in the whole table, the highest five-year total return in the whole table, the lowest five-year standard deviation in the whole table, the highest price on 3/9/2012 relative to its pre-crash high in the whole table, and the smallest crash drawdown in the whole table. It's the superstar of Vanguard ETFs.

In second place for sectors, the best choice is probably VHT - the Health Care ETF - because of its low five-year standard deviation, low drawdown during the crash, and decent five-year total return. And its Sortino ratio, while not as good as some of the other sector ETFs, is stong compared to the stock ETFs.

Finally, for international stocks, VWO - Emerging Markets - is probably the only choice worth considering. It has a high Sortino ratio and better five-year total return than any of the domestic stock funds, but its crash drawdown, price on 3/9/2012 relative to its pre-crash high, and five-year standard deviation are daunting. Again, not a choice for the faint of heart.

To close the celebration, let's drink a toast to another three years of rising markets! Although that would be nice, I'm not betting on it.